High-Frequency Trading Hits a Wall

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The number of high-frequency trading firms continues to grow, but the volume of shares traded by the important group is waning.

Paul Adcock

That's the conclusion of a group of exchange executives who derive at least half their volume from high-frequency trading shops.

"I'm signing account documents at a record pace," Paul Adcock, an NYSE Euronext executive vice president who heads operations at NYSE Arca, told attendees at a recent industry conference. "But those types of accounts struggle when the VIX is where it is."

The VIX, an index created by the Chicago Board Options Exchange to measure market expectations of volatility, has dropped to about 25 recently, after soaring to nearly 80 two years ago. Lower volatility translates into fewer opportunities for active traders.

Firms whose trading strategies are classified as high-frequency are those executing at least 1,000 trades per second, industry experts maintain. By one count, there are about 400 such firms.

"High-frequency trading is not going to go away anytime soon," Brian Hyndman, a Nasdaq OMX senior vice president responsible for transaction services, said at the same conference. "But it is no longer in the growth stage. We are probably mid-field." About 55 percent of Nasdaq's volume comes from high-frequency trading firms, Hyndman said, with the amount dependent on the level of the VIX.

The executives were speaking at this year's annual conference of the Chicago chapter of the Security Traders Association.

Bryan Harkins, an executive with the Direct Edge ECN, noted that the market is "saturated" with high-frequency shops. He doesn't expect overall industry volume to increase substantially in the next few years.

In the past three years, volume has doubled due to the activities of high-frequency traders. Average daily volume is about 10 billion shares today. That compares to 5 billion shares in early 2007.

"Someone leaves a high-frequency trading shop to start a new one," Harkins said. "You do a meeting [with them] and they say 'We're going to do 100 million shares a day.' You get all excited with the next big account and then six months later they're struggling to stay in business." About half of Direct Edge's volume comes from high-frequency trading firms, Harkins said.

Adcock noted that the changes in volume at NYSE Arca's top five high-frequency accounts mirror those of the VIX "almost perfectly." And because most high-frequency strategies are similar, he said, only the "biggest and fastest will make those strategies work." Between 50 and 60 percent of Arca's volume comes from high-frequency trading firms, Adcock said.

Joe Bracco, an executive with BATS Exchange, blames the decline in trading opportunities for high-frequency firms on a different culprit. "Internalization, or removing retail orders from exchanges, is hurting the high-frequency shops," he charges. "As the percentage internalized grows, market quality degrades." About 60 percent of BATS' volume comes from automated market makers, or high-frequency trading firms, Bracco said.